Jiangsu Dingsheng New Materials Ltd (SHSE:603876) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Jiangsu Dingsheng New Materials Joint-Stock Co.,Ltd (SHSE:603876) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Jiangsu Dingsheng New Materials Ltd

How Much Debt Does Jiangsu Dingsheng New Materials Ltd Carry?

The chart below, which you can click on for greater detail, shows that Jiangsu Dingsheng New Materials Ltd had CN¥7.11b in debt in March 2024; about the same as the year before. However, because it has a cash reserve of CN¥6.76b, its net debt is less, at about CN¥349.9m.

How Healthy Is Jiangsu Dingsheng New Materials Ltd's Balance Sheet?

The latest balance sheet data shows that Jiangsu Dingsheng New Materials Ltd had liabilities of CN¥13.8b due within a year, and liabilities of CN¥3.20b falling due after that. Offsetting this, it had CN¥6.76b in cash and CN¥3.76b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.45b.

This is a mountain of leverage relative to its market capitalization of CN¥8.98b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Jiangsu Dingsheng New Materials Ltd has a low net debt to EBITDA ratio of only 0.33. And its EBIT covers its interest expense a whopping 29.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Jiangsu Dingsheng New Materials Ltd's saving grace is its low debt levels, because its EBIT has tanked 75% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Jiangsu Dingsheng New Materials Ltd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Jiangsu Dingsheng New Materials Ltd produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While Jiangsu Dingsheng New Materials Ltd's EBIT growth rate has us nervous. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. We think that Jiangsu Dingsheng New Materials Ltd's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Jiangsu Dingsheng New Materials Ltd you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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